6 Questions All Rookie Investors Should Ask

By Matt Bell on 6 February 2018 0 comments

The first time you got behind the wheel of a car, you were probably a little intimidated. The same can be true if you're just getting started with investing. Here are some questions that may be on your mind, along with answers designed to help you begin your investing journey with the knowledge you need to succeed.

1. Why should I invest?

Especially if you're young, investing might not seem very urgent. Investment goals, such as retirement, may seem distant and vague.

The financial services industry has tried everything to get people to recognize the importance of investing for retirement, even using photo-enhancing software to show young people what they may look like when they're 65 or 70. A 2012 Merrill Edge study actually found the tactic somewhat effective in motivating people to save more for their later years.

Assuming you don't have access to such technology, maybe the best way to find the motivation to invest is to consider the cost of waiting. Crunching the numbers just may be the wake-up call you need.

2. What's the harm in holding off a little while?

The sooner you start investing, the less you'll have to invest each month in order to meet your goals.

Let's say you're 25 years old, plan to retire at age 70, and want to accumulate $1 million by then. Assuming a 7 percent average annual return, you would need to invest about $275 per month. Even waiting just five years will significantly increase that amount. Starting at age 30, you would need to invest about $361 per month in order to accumulate $1 million by age 70.

Here's another way to think about it. If you invested $200 per month from age 25 until age 70 and generated an average annual return of 7 percent, you'd end up with about $733,804. Wait until age 30 to start investing $200 per month, and you'll end up with $512,663.

That's amazing, isn't it? By investing for just five fewer years, you will invest just $12,000 less than if you had started at age 25. And yet, because of the power of compounding — more accurately, because of missing out on five years' worth of the power of compounding — you'll end up with about $221,000 less. That's a huge penalty for waiting. (See also: 11 Investing Tips You Wish You Could Tell Your Younger Self)

3. How much should I invest?

To get a general sense about how much to invest each month, use the Fidelity Retirement Score calculator. Once you run some initial numbers, you'll be able to see how changing some of your variables, such as how much to invest and when to retire, will impact your how much money you end up with.

4. Should I use my company's 401(k) plan or an IRA?

The key to answering this question is whether your employer offers a match on some of the money you would contribute to its 401(k) plan. If so, start there.

In a typical arrangement, an employer will match your contributions up to 6 percent of your salary. If yours will contribute a dollar for every dollar you put in, that's a guaranteed 100 percent return on your money. If it will match 50 cents for every dollar you contribute, that's a guaranteed 50 percent return on your money. Don't miss out.

If your employer doesn't offer a match, the decision depends on the investment options it offers. There are still some employers whose plans contain a strange mix of mutual funds with high fees (you should not be limited to funds with "expense ratios" higher than 1 percent). If that's the case with your employer's plan, you may be better off using an IRA. However, even with a solid 401(k) plan at your disposal, don't think an IRA isn't for you. Contributing to both plans can give you a further leg up in your retirement savings strategy. (See also: 401(k) or IRA? You Need Both)

5. What should I invest in?

It used to be a lot more complicated and intimidating to figure out what investments to make. Today, target-date funds have simplified the process. By choosing a single mutual fund that has the year of your intended retirement date as part of its name, such as the Fidelity Freedom 2040 Fund, you'll gain a portfolio that's diversified across stocks, bonds, and other asset classes in a way that's appropriate for someone your age. As you get older, the fund will automatically adjust its investment mix, becoming more conservative as you near your target retirement date. (See also: What You Need to Know About the Easiest Way to Save for Retirement)

6. What can I expect from my investments?

In short, you can expect that the ride will not always be smooth. Last year, the S&P 500 generated a nearly 22 percent return, but in 2008 it fell 37 percent.

Investing always comes with risk, and there's no way to predict how each year will turn out. A solid approach is to build a diversified portfolio, perhaps through a target-date fund, and commit to staying with it in good years and bad.

The longer you stay invested, the better your odds of success. As Morningstar documented in its 2017 Fundamentals for Investors report, from 1926 through 2016, 74 percent of one-year returns from the U.S. stock market were positive, 86 percent of five-year returns were positive, and 100 percent of 15-year returns were positive.

As with so many things, the best way to learn about investing is to get started. Taking the steps described above should get you moving in the right direction.

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6 Questions All Rookie Investors Should Ask

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